Topic 1
Trade-offs in Economic
Decision-making
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Economic scarcity and trade-offs
(1 of 6)
 Economics is the study of the choices people and
societies make to attain their unlimited wants, given
their scarce resources.
 The central economic issue involves scarcity.
 World resources at any one point in time are
limited/scarce.
 Resources: Inputs used to produce goods and
services, including natural resources such as land,
water and minerals, labour, capital and entrepreneurial
ability.
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Economic scarcity and trade-offs
(2 of 6)
 Human wants are unlimited – leisure, possessions,
environment, world concerns, lifestyle…
– Scarcity: The situation in which unlimited wants
exceed the limited resources available to fulfill
them.
 In economics we study how people make choices and
interact in markets.
– Market: A group of buyers and sellers of a good or
service and the institution or arrangement by which
they come together to trade.
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Economic scarcity and trade-offs
(3 of 6)
Three important ideas in economics are:
1.
People are rational.
2.
People respond to economic incentives.
3.
Optimal decisions are made at the margin.
– Marginal analysis: Analysis that involves
comparing marginal benefits and marginal costs.
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Economic scarcity and trade-offs
(4 of 6)
 Trade-offs force society to make choices.
 From a firm’s point of view, a trade-off must be made
because of scarcity; producing more of one good or
service means producing less of another good or
service.
 Trade-offs apply to three fundamental economic
questions:
1. What goods and services will be produced?
2. How will the goods and services be produced?
3. Who will receive the goods and services
produced?
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Economic scarcity and trade-offs
(5 of 6)
 When choosing between alternative options,
economists use the concept of opportunity cost.
 Opportunity cost: The opportunity cost of any activity
is the highest-valued alternative that must be given up
to engage in the activity under consideration.
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Economic scarcity and trade-offs
(6 of 6)
Examples:
– University students may choose whether to take a
business degree or a science degree.
– A business will choose between different
investment options or projects.
– A government must choose between different
policies, such as spending more on education or
more on health.
 In economics, opportunity cost is essential - all cost
measurements include the opportunity cost.
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Different economic systems
(1 of 3)
 The choices available depend on the economic
system of the country.
 Centrally planned economy: An economy in which
the government decides how economic resources will
be allocated.
 Market economy: An economy in which the decisions
of households and firms interacting in markets
determine the allocation of economic resources.
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Different economic systems
(2 of 3)
 A central feature of market economies is consumer
sovereignty.
 Consumer sovereignty occurs because firms must
produce goods and services that meet the wants of
the consumers, or the firm will go out of business.
 It is therefore consumers who ultimately decide what
goods and services will be produced.
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Different economic systems
(3 of 3)
The modern ‘mixed’ economy
 Mixed economy: An economy in which most
economic decisions result from the interaction of
buyers and sellers in markets, but in which the
government plays a significant role in the allocation of
resources.
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Economic models (1 of 4)
 Economic model: A simplified version of the reality
used to analyse real-world economic situations.
 Models are used to answer questions. For example:
– Will a higher price of apples lead to a decrease in
the quantity sold?
– Will higher wages increase unemployment?
– Do university graduates earn higher wages?
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Economic models (2 of 4)
To develop a model economists generally follow
these steps:
1.
Decide on the assumptions to be used in developing the
model.
2.
Formulate a testable hypothesis – a statement about an
economic variable that might be correct or incorrect.
3.
Use economic data to test the hypothesis.
4.
Revise the model if it fails to explain the economic data.
5.
Retain the revised model to help answer similar
economic questions in the future.
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Economic models (3 of 4)
 In testing hypotheses, economists distinguish between
correlation and causality.
 It is difficult to prove causality; we use economic
theory, models, history and other studies to support
our conclusions.
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Economic models (4 of 4)
Positive and normative analysis
 Positive analysis: Analysis concerned with what is.
– Involves value-free statements that can be tested by
using the facts.
– Economics focuses on positive analysis.
 Normative analysis: Analysis concerned with what we
think ought to be.
– Involves making value judgments that cannot be
tested.
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